Four building blocks of efficient capital markets

Speech by David Lawton, Director of Markets, FSA at the Practising Law Institute Conference


Thank you for inviting me today as your keynote speaker. Given the breadth of issues in the capital markets this conference is covering, I thought it would be of interest to provide an overview of some of the key areas we’re working on to support capital markets, both at a domestic and European level. In particular, I will focus on four specific components or prerequisites to efficient capital markets:

Promoting ethical market behaviour in the market area – We are pursuing this through monitoring the integrity of participants’ behaviour in trading and having the right deterrents in place to help assure market cleanliness.

  • Effective corporate governance – We are making sure the Listing regime remains relevant in the current market context.
  • Effective intermediation and resilience to deliver market stability – Greater transparency and better risk management of OTC derivatives is a major goal here.
  • Delivering investor protection – A strong client asset regime that delivers investor protection at the right level is an important element here.

As I’m sure your panel discussions today will reflect, all these areas are currently under debate. There are many perspectives and the questions posed do not necessarily have straightforward answers. I’ll touch on some of the central arguments and the FSA’s role, particularly on the markets side in these debates.

Ethical market behaviour

We all have a vested interest in making sure that the UK, as a world leading financial market, has high standards. One aspect of this is maintaining market cleanliness. It is easy for discussions on market cleanliness to become academic and abstract, but the goal is clear: it is important that market participants and investors have confidence in the fairness of UK markets, because bluntly, no one wants to operate in a market where they cannot trust the other side.

We saw with LIBOR how a lack of integrity by some of the people involved in the process of setting the rate undermined the confidence in markets. The work on restoring confidence will not end when the Government’s regulatory regime for LIBOR, with new requirements for governance and systems and controls around the various processes is implemented.

These requirements are only tools to help firms ensure their staff act with integrity. The less easy to define part is firms working to build cultures where their staff are encouraged and rewarded for acting with integrity. Bringing about this kind of change may be costly, but that cost needs to be weighed against the consequences we have seen firms having to face when they do not give due attention to culture, and the damage done to the integrity of the whole industry.

Market abuse regulation

A key component of ensuring high standards of market cleanliness is our robust approach to market abuse. I’m told that the queue of taxis outside this building used to be a seen as a sign of M&A activity, but they’re just as likely now to hint at the amount of Enforcement action we’re undertaking.  The latest ruling by the Upper Tribunal on the Swifttrade case highlights that we are willing to take on tough cases.

And we’re not alone in taking a tougher approach. There is a general impetus in the EU among all the member states to move to a much more robust and ambitious market abuse regulatory framework.

We are working with other member states to ensure that the negotiation on the Market Abuse Regulation in Europe will result in strong deterrents and sanctions for market abuse. A couple of critical areas for us include:

  • Pushing for a suitably strong framework that ensures we can take action against dealing abuses – I know that this brings us on to the thorny issue of having a clear definition of inside information but it is equally important that regulators have the flexibility and ability to take action against all unacceptable behaviour in the markets.
  • Addressing pre-soundings within the regulation – These, as you will know, are the interactions between market participants which are carried out in order to gauge potential investor appetite in a potential transaction. This is an important and valuable practice, but it is appropriate for regulation to ensure that the market avoids committing market abuse when conducting soundings.


Strengthening legislation on market abuse is coupled with our work to ensure that market participants demonstrate integrity throughout their careers. One of the ways we do this is watching them carefully. As markets have become more complex, surveillance has had to develop very quickly to keep pace. This is a challenge not just in terms of keeping up with new and increasingly complex technology, but also one of how best to monitor a market that is increasingly fragmented,  how best to put in place the surveillance of multiple-trading venues, multiple assets across multiple countries in the world.

I hope that gives you some sense of the intensity of work the FSA and other competent authorities are doing in this area, all of which are moving in the right direction to result in a more robust market abuse regime.

Effective corporate governance

In the sphere of corporate governance, regulators, firms and investors continue to work to find the right balance between encouraging growth and providing for a suitable level of investor protection. This work is done in the challenging context of changing market conditions and the introduction of new business models to the UK-listed market.

My responsibility is to maintain a regime flexible enough for the range of suitable firms who want to be listed. The framework has to be robust and result in sufficient disclosure from listed firms to allow investors to make informed decisions. You could describe me as both groundsman and umpire of the Listing Regime.

Enhancing the effectiveness of the Listing Regime and feedback on CP12/2

As you’ll be aware, we’ve recently been reviewing our regime to ensure that it properly reflects recent changes in market practices. Last October we published a Consultation Paper, Enhancing the effectiveness of the Listing Regime and feedback on CP12/2, which provided a general stocktake of the regime and reviewed a number of trends being observed in the listing arena.

We believe that the great majority of premium-listed issuers already fully subscribe to the high standards of governance required of such issuers. We also believe that the current comply or explain approach against the FRC’s UK Governance Code, as required by the Listing Regime for premium listed issuers, is overall the right one.

We do, however, recognise that there needs to be a balance between investor stewardship and maintaining a regime, which gives investors sufficient information and power to exercise that regime. We’re currently looking at how we can enhance the Listing Rules in the area of governance. In these proposals we take into account that the standard listing segments will need to continue to be able to accommodate issuers not able to comply with requirements applicable to the premium segment.

We’ve put forward proposals on how we can optimise the entry criteria in the premium segment. Our proposals include:

  • implementing the concept of a controlling shareholder;
  • requiring that an agreement is put in place to regulate the relationship between such a shareholder and the listed company;
  • insisting on a majority of independent directors on the board where a controlling shareholder exists; and
  • prohibiting certain voting arrangements that lower investor protection within the premium segment.

We have also put forward some proposals on how we can ensure that the eligibility requirements continue to apply as meaningful ongoing obligations. Among the proposals we are putting forward include introducing a new dual-voting requirement to elect independent directors and provide guidance on what constitutes an independent business that is eligible for premium listing. We also put forward some proposals on how the regime can better empower independent shareholders to approve material changes to the relationship agreement.

Efficient and resilient secondary markets

I said in a speech a year ago, that if we are to deliver market stability – that is, both efficient price formation and the smooth functioning of markets – then the shortcomings in transparency and risk management in OTC derivative markets must be addressed.  That point remains true and, in Europe, EMIR will move us significantly forward in that task by introducing central clearing and reporting obligations for OTC derivatives.


The proposed revisions to MiFID will help further. They complete the EU’s implementation of G20 commitments by introducing an obligation to trade certain OTC derivatives on organised trading venues. We will also have a stronger, more structured framework for the trading of derivatives on organised trading venues through the introduction of a framework of pre and post-trade transparency and the creation of the new category of venues, Organised Trading Facilities (OTFs).

The details of those changes have yet to be settled and the views are still quite diverse.  We are supporting the Treasury in seeking to ensure that the changes promote stability without damaging the ability of corporates to finance their businesses and manage their commercial risks. There should be sufficient flexibility in the transparency regime to reflect the fact that the liquidity profile of derivatives is often very different from that of blue chip shares.  

There has also been extensive debate about the impact of high-frequency trading (HFT) on market behaviour and stability. We have the significant benefit of the work of the Foresight Programme on computer trading in helping us to understand what has been happening and where developments might go next.   

The Foresight report indicated that HFT may have several beneficial effects on markets but may cause instabilities in financial markets in specific circumstances. Regulators will need to continue to pay close attention to the evolution of HFT and to research looking at its effects on markets.

Following on from the ESMA-automated trading guidelines, we support using the MiFID review to introduce more detailed, robust and legally enforceable risk controls for all firms and trading venues in relation to their automated trading. And all participants that have the potential to pose significant risks to the system should be regulated. We therefore welcome proposals for the regulation of HFT firms that currently fall outside of the scope of MiFID I.

Protecting client assets

Alongside the need to ensure market cleanliness and stability, we need to support these components with the maintenance of appropriate investor protection. For this reason I would like to expand on our work on the client asset regime. Martin Wheatley recently gave a speech in which he highlighted the extent to which we rely on the quality of the protections afforded by the client assets regime. The regime is particularly important because it has a direct impact on the full spectrum of consumers, retail to wholesale.  The strength of this regime assures investors of the high quality of the UK markets and puts in place important barriers to a firm failure spreading financial detriment to counterparties and investors.

Developing the regime

As you’ll already be aware, we are having a stocktake of the regime, looking at where we can bring about improvements that will provide further assurance to investors. We have published a Discussion Paper that begins a conversation with industry on where improvements should be made. The Discussion Paper centres around:

  • increasing the speed of return of client assets following a firm’s failure;
  • increasing the proportion of assets that are returned; and
  • reducing the market impact of the failure of firms holding client assets.

Just like the other policy debates I have touched on this morning, what we are trying to achieve with the client asset regime is a juggling act. We are trying to balance the speed with which assets can be returned with accuracy about who owns what – while acknowledging that either way, some sacrifices will be made. We are trying to balance how much investor protection the regime can afford with who bears the costs. There are no self-evident answers in these debates.

This debate is also important to us because as regulators we can only do so much in this space. Our client assets regime is built on the legislative framework that includes insolvency and company law, which imposes some limitations that, for example, the US regime structurally does not have to deal with.

To sketch this out with some contrasts – in the US, insolvency practitioners are responsible for returning client money and assets, but are not exposed to the same personal liabilities as UK practitioners.  Certain exemptions allow them to make decisions without the risk of personal litigation.

Another difference is the Securities Investor Protection Corporation (SIPC) in the US.  This is an industry-funded insurance scheme for clients of failed brokerage firms – in effect an FSCS for investment firms that covers clients up to $500,000 each. It is these sort of structural differences that make asset recovery on the other side of Atlantic speedier.

So because of the limitations we work within in this area, it is important that we make sure that the contributions we make have an optimal result.


There are number of areas key to the success of capital markets where the FSA is in open debate with industry, stakeholders and other regulators on where future improvements should be made in the various regimes that underpin the capital markets. There are no straightforward answers.

  • In promoting ethical market behaviour, we are engaging with Europe to reach a result in MAR, which will ensure a more robust approach to market abuse. This is being supported by a strong surveillance regime, which is also under international review.
  • Making sure that the Listing regime is responsive to current market conditions and maintains the reputation of the Premium listing brand.
  • Ensuring the effectiveness of intermediates’ resilience through MIFID.
  • Continuing the dialogue on how the Client Asset Regime can ensure the return of assets sufficiently quickly while balancing the demand for accuracy over who owns the assets.

Efficient, resilient and fair capital markets are built on a range of foundations. I’ve talked about four today. They are not the only key building blocks, but they are important. I hope you have found my description of how we are working to strengthen them useful and that this speech will be a starting point for lively debate in today’s sessions.